FACULTY OF LAW

ASSIGNMENT
Corporate law

TOPIC:
Formation of company, Position & liabilities of promotors

NAME: SWAPNIL SANKRITYA

COURSE: B.A.L.L.B. (HONS) REGULAR
SERIAL NO: 57
STUDENT ID- 202201814
SEMESTER: SIXTH (2022-2027)
SUBMITTED TO- Dr. Qazi Mohammed Usman
 INDEX

INTRODUCTION

WHAT IS A COMPANY

TYPES OF COMPANY

POSITION OF PROMOTERS

LIABILITIES OF PROMOTERS

LIABILITIES WITH PROSPECTUS

CONCLUSION
 INTRODUCTION

The formation of a company is a vital step in the establishment of any business organization.
It involves the transformation of a business idea into a legal entity recognized by law. This
process includes various stages such as promotion, incorporation, and commencement of
business. Among these, the role of promotion is of particular importance, as it lays the
foundation for the entire process. This is where the promoters come into the picture.

Promoters are individuals or groups who undertake the preliminary steps required to form a
company. They identify the business opportunity, arrange initial funding, prepare essential
documents like the Memorandum and Articles of Association, and complete the legal
procedures necessary for incorporation. In essence, promoters act as the driving force behind
the creation of a company, taking on the responsibility of bringing it into existence.

Despite their crucial role, promoters occupy a unique legal position. Since the company does
not legally exist during the promotion stage, they cannot act as its agents or trustees in the
traditional sense. However, they are held to a high standard of honesty and transparency, and
are expected to act in the best interest of the future company. Any breach of duty—such as
misrepresentation, non-disclosure of profits, or entering into unauthorized pre-incorporation
contracts—can result in legal liabilities.

This project aims to explore the detailed process of company formation, examine the legal
position of promoters, and analyse the nature and extent of their liabilities under corporate
law.
 WHAT IS A COMPANY

Company is an association of person who takes their meals together. The term is derived from

the Latin word ("com" meaning "with" or "together"; "panis" that is "bread") Section 2(20) of

Companies Act, 2013 states that a company means - any association of person registered

under the present or the previous companies act. It is called a "body corporate" because the

persons composing it are made into one body by incorporating it according to the law and

clothing it with legal personality

Under common law, a company is defined as a `legal person' or `legal entity' separate from

its member and capable of being surviving beyond the lives of its members. Whereas it is

not merely legal, it is rather a legal device for attainment of any social or economic end and

to a large extent publicly and socially responsible. It is, therefore, a combined political,

social, economic and legal institution.

According to Haney, “Joint Stock Company is a voluntary association of individuals for

profit, having a capital divided into transferable shares. The ownership of which is the

condition of membership”.

According to Chief Justice Marshall of USA, “A company is a person, artificial, invisible,

intangible, and existing only in the contemplation of the law. Being a mere creature of law, it

possesses only those properties which the character of its creation of its creation confers upon

it either expressly or as incidental to its very existence”.

 FORMATION OF A COMPANY

(1) A Company may be formed for any lawful purpose by—

(a) seven or more persons, where the company to be formed is to be a public company;
(b) two or more persons, where the company to be formed is to be a private company; or (c)
One Person, where the company to be formed is to be One Person Company that is to say,
a private company, by subscribing their names or his name to a memorandum and
complying with the requirements of this Act in respect of registration:

Provided that the memorandum of One Person Company shall indicate the name of the other
person, with his prior written consent in the prescribed form, who shall, in the event of the
subscriber’s death or his incapacity to contract become the member of the company and the
written consent of such person shall also be filed with the Registrar at the time of
incorporation of the One Person Company along with its memorandum and articles:

Provided further that such other person may withdraw his consent in such manner as may be
prescribed:

Provided also that the member of One Person Company may at any time change the name of
such other person by giving notice in such manner as may be prescribed:

Provided also that it shall be the duty of the member of One Person Company to intimate the
company the change, if any, in the name of the other person nominated by him by indicating
in the memorandum or otherwise within such time and in such manner as may be prescribed,
and the company shall intimate the Registrar any such change within such time and in such
manner as may be prescribed:

Provided also that any such change in the name of the person shall not be deemed to be an
alteration of the memorandum.

(2) A company formed under sub-section (1) may be either—

(a) a company limited by shares; or (b)

a company limited by guarantee; or (c)
an unlimited company.
 TYPES OF COMPANY

Joint stock company can be of various types. The following are the important types of
company:

1. Classification of Companies by Mode of Incorporation Depending on the mode of

incorporation, there are three classes of joint stock companies.

A. Chartered companies. These are incorporated under a special charter by a monarch.

The East India Company and The Bank of England are examples of chartered incorporated in
England. The powers and nature of business of a chartered company are defined by the charter
which incorporates it. A chartered company has wide powers. It can deal with its property and
bind itself to any contracts that any ordinary person can. In case the company deviates from its
business as prescribed by the charted, the Sovereign can annul the latter and close the company.
Such companies do not exist in India.
B. Statutory Companies. These companies are incorporated by a Special Act passed by
the Central or State legislature. Reserve Bank of India, State Bank of India, Industrial Finance
Corporation, Unit Trust of India, State Trading corporation and Life Insurance Corporation are
some of the examples of statutory companies. Such companies do not have any memorandum
or articles of association. They derive their powers from the Acts constituting them and enjoy
certain powers that companies incorporated under the Companies Act have. Alternations in the
powers of such companies can be brought about by legislative amendments. The provisions of
the Companies Act shall apply to these companies also except in so far as provisions of the Act
are inconsistent with those of such Special Acts [Sec 616 (d)] These companies are generally
formed to meet social needs and not for the purpose of earning profits.

C. Registered or incorporated companies. These are formed under the Companies Act,
1956 or under the Companies Act passed earlier to this. Such companies come into existence
only when they are registered under the Act and a certificate of incorporation has been issued
by the Registrar of Companies. This is the most popular mode of incorporating a company.

Registered companies may further be divided into three categories of the following.

1. Companies limited by Shares: These types of companies have a share capital and the
liability of each member or the company is limited by the Memorandum to the extent
of face value of share subscribed by him. In other words, during the existence of the
company or in the event of winding up, a member can be called upon to pay the amount
 remaining unpaid on the shares subscribed by him. Such a company is called company
limited by shares. A company limited by shares may be a public company or a private
company. These are the most popular types of companies.
2. Companies Limited by Guarantee: These types of companies may or may not have a
share capital. Each member promises to pay a fixed sum of money specified in the
Memorandum in the event of liquidation of the company for payment of the debts and
liabilities of the company [Sec 13(3)] This amount promised by him is called
‘Guarantee’. The Articles of Association of the company state the number of members
with which the company is to be registered [Sec 27 (2)]. Such a company is called a
company limited by guarantee. Such companies depend for their existence on entrance
and subscription fees. They may or may not have a share capital. The liability of the
member is limited to the extent of the guarantee and the face value of the shares
subscribed by them, if the company has a share capital. If it has a share capital, it may
be a public company or a private company. The amount of guarantee of each member
is in the nature of reserve capital. This amount cannot be called upon except in the event
of winding up of a company. Nontrading or non-profit companies formed to promote
culture, art, science, religion, commerce, charity, sports etc. are generally formed as
companies limited by guarantee.
3. Unlimited Companies: Section 12 gives choice to the promoters to form a company
with or without limited liability. A company not having any limit on the liability of its
members is called an ‘unlimited company’ [Sec 12(c)]. An unlimited company may or
may not have a share capital. If it has a share capital it may be a public company or a
private company. If the company has a share capital, the article shall state the amount
of share capital with which the company is to be registered [Sec 27 (1)] The articles of
an unlimited company shall state the number of members with which the company is to
be registered.

On the Basis of Number of Members On the basis of number of members, a company

may be:

(1) Private Company, and (2) Public Company.

 POSITION AND LIABILITIES OF PROMOTERS

Promotion

Promotion of companies is a hydra-headed task. Promotion generally means forming a

company. In India we have seen promotion generally is done by individuals who are
entrepreneurs as ‘occasional promoters. In case of promotion of private companies, the
intended promoters sign a ‘Prior Agreement’ wherein they lay down the terms and condition
and the way they want to establish a company which is followed by a ‘Promoters’
Agreement’ subsequently after incorporation wherein they record their contributions in terms
of pooling of capital.

The term promoter was not defined in Companies Act, 1956 but was frequently used in
various section e.g. secs. 56, 62, 69, 76, 478 & 519. In Whaley Bridge Co.v. Green Bowell LJ1
while defining the term promotion held that ‘promotion’ is not a term of law but of business
operations familiar to the commercial world, by which a company is generally brought in to
existence. Promotion includes wide range of commercial activities which include many
technical and non-technical operations’

Definition of Promoter in Companies Act, 2013

Recently in the Companies Act 2013 the term was defined in section 2(69) in following way:
“Promoter” means a person—

(a) who has been named as such in a prospectus or is identified by the company in the
annual return referred to in section 92; or

(b) who has control over the affairs of the company, directly or indirectly whether as a
shareholder, director or otherwise; or

(c) in accordance with whose advice, directions or instructions the Board of Directors of
the company is accustomed to act:

Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a
professional capacity

1
1897 QBD 111
Legal Position of Promoters

Promoters are deeply involved in incorporation process of company so a pertinent question

arises what is the legal position of the promoters in the company. Promoters are not agents as
before incorporation the company is non est (does not exist) in the eye of law so there can be
no principal. They are also not trustees, as company is not a beneficiary. They are in fiduciary
capacity as in Erlanger v. New Somrero phosphate co. Ltd2. Cairns LJ said that, “The
promoters undoubtedly stand in a fiduciary position. They have in their hand the creation and
moulding of the company. They have the power of defining how and when and in what shape
and under whose supervision it shall come in to existence and begin to act as a trading
corporation.”

Liabilities of Promoters

The companies Act, 2013 in various sections mention about promoter’s role in corporate
governance specially in sections Sec 2(59), 2(60), 7, 26, 34, 35, 42(10), 92, 102, 149, 167,
184, 230, 266, 284, 289, 300, 339, 361. Due to a series of corporate scams like Satyam,
Enron, Sahara, Saradha etc., the new Act was concerned to plug the loopholes wherein
entrepreneurs are abusing corporate personality as promoters of company. In section 2(59) &
2 (60) Companies Act, 2013 defines the term ‘Officer’ and ‘Officer in default’. Section 2(59)
defines the term “officer” which includes any director, manager or key managerial personnel
or any person in accordance with whose directions or instructions the Board of Directors or
any one or more of the directors is or are accustomed to act. If we see this definition closely
though it does not mention about promoter but because of the definition of term promoter as
defined in section 2 (69), the promoter is an officer of company. Because section 2(59) and 2
(69) have something in common i.e. ‘any person in accordance with whose directions or
instructions the Board of Directors or any one or more of the directors is or are accustomed to
act.’ A promoter holds a better position in corporate governance and has information to
crucial and sensitive information which are undisclosed and he can misuse such information
for personal and vested interests so the new Companies Act holds the promoter liable as
officer and officer in default wherever he contravenes the provisions of the Companies Act
and other corporate and securities laws. A promoter is generally liable for furnishing wrong
information and credentials for incorporation of company3 , owes a civil and criminal liability

2
1878 3 AC 1218.
3
The Companies Act (Act 18 of 2013).S.7.
for misstatement in prospectus4, disclosures of interests in periodic annual return filed to
Registrar and SEBI, disclosure of interests in notice served in AGM5. He also plays crucial
role in appointment of first directors of the company, if directors are not appointed by
promoters, they are treated as deemed directors of the company6. He also plays crucial role in
corporate mergers, amalgamation and takeovers7. He also plays very crucial role in winding
up of the affairs of the company.8

Companies Act, 2013 under sections 336 to 342 provides for various offences and
punishment there for, committed by officers of companies which equally covers promoters
which comes out during winding up of company. Section 447 to 453 provides for certain
offences which are committed by officers of company and others and make it punishable.

4
The Companies Act 2013 (Act 18 of 2013).S.34 and 35.
5
The Companies Act 2013 (Act 18 of 2013).S.102 & 184.
6
The Companies Act 2013 (Act 18 of 2013). S.49-152.
7
The Companies Act, 2013 (Act 18 0f 2013) S.230
8
The Companies Act 2013 (Act 18 of 2013). S.266, 284, 289 & 300
Section 447 provides that, “Without prejudice to any liability including repayment of any
debt under this Act or any other law for the time being in force, any person who is found to
be guilty of fraud, shall be punishable with imprisonment for a term which shall not be less
than six months but which may extend to ten years and shall also be liable to fine which shall
not be less than the amount involved in the fraud, but which may extend to three times the
amount involved in the fraud: Provided that where the fraud in question involves public
interest, the term of imprisonment shall not be less than three years.”

SEBI under SEBI Act, 19929 is also have enormous powers to prevent such people who are
indulged in fraudulent activities to have access to capital market as issuer, investor or
intermediary.

Liabilities Related with Prospectus

Section 26 of the Companies Act, 2013 and ICDR Regulations 2009 provides for contents
and matters to be provided in offer document i.e. prospectus. Prospectus is a document which
presents the general information, financial information and issue information before
prospective investors so as to help them to take decision regarding share subscription of the
particular company. In case if the prospectus includes any statement which is untrue or
misleading in form or context in which it is included or where any inclusion or omission of
any matter is likely to mislead then promoters of the company owe civil and criminal liability
under section 34 and 35 of the Act and accordingly they shall be liable for punishment under
section 447 with imprisonment for a term which shall not be less than six months but which
may extend to ten years and shall also be liable to fine which shall not be less than the
amount involved in the fraud, but which may extend to three times the amount involved in
the fraud. Apart from this the prospective investors can file a civil suit or any other action for
rescission, suit for contractual breach and damages in section 37 of the Act for misleading
information in prospectus. William Derry v. Henry Peek10 is a case upon which the whole
provisions of section 34 and 35 are based. In this case a company applied to British Board of
Trade for license for running tramways by steam power and in apprehension that they will get
the license issued a prospectus to raise capital stating that the company has been licensed to
run tramways by steam-power but actually they did not get. The directors of the company

9
Chapter IV, Chapter VA, Chapter VI A specially deals with power of SEBI with regard to Capital Market
(1889)14 AC 337.
10
(1889) LR 14 App Cas 337.

10
were not held guilty of fraud. Lord Herschell held that, “I think they were mistaken in
supposing that the consent of the Board of Trade would follow as a matter of course because
they had obtained their Act. In short, I think they honestly believed that what they asserted
was true, and I am of opinion that the charge of fraud made against them has not been
established.”

But under section 35 general and special defences are available to such people who are sued
under section 35 for criminal liability. If they are rendering professional services or they
withdrew their consent for authorizing the issue or they are ignorant about misstatement in
prospectus; they shall not be liable.

CONCLUSION

The formation of a company is a significant legal process that involves several

stages—promotion, incorporation, and commencement of business. Among
these, the role of promoters is foundational. A promoter is the person who
conceives the idea of forming a company, carries out preliminary work such as
drafting the memorandum and articles of association, arranging capital, and
ensuring registration under the Companies Act, 2013. However, a promoter does
not have a statutory definition under the Act but is broadly understood under
Section 2(69) of the Companies Act, 2013.

Promoters occupy a fiduciary position in relation to the company they promote.

This implies they are expected to act honestly and not misuse their position for
undue advantage. Courts have held that promoters must not make secret profits
and must disclose any personal interest in transactions related to the company
Lagunas Nitrate Co. v. Lagunas Syndicate11,Failure to do so may render them
liable for breach of duty and restitution.

11
[1899] 2 Ch. 392

11
Moreover, promoters cannot bind the company through pre-incorporation
contracts unless the company adopts them post-incorporation, as ruled in Kelner
v. Baxter12. This shows the legal limitations of a promoter's authority and the
need for statutory compliance.

While promoters play an essential role in laying down the framework of a

company, their liabilities also ensure that they act responsibly and, in the
company’s, best interest. The law strikes a balance between recognizing their
initiative and safeguarding the interests of future shareholders and the company
itself.

In summary, the role of promoters in company formation is indispensable, but it

is equally important that their duties and liabilities are well regulated to ensure
transparent and ethical conduct during the formative stages of a company.

12
(1866) LR 2 CP 174

12